Brazil: The Brazilian Regulator Implements The Recommendations Of Basel III

On March 1st, 2013, the Central Bank of Brazil (Banco
Central do Brasil – Bacen) released a set of four
Resolutions issued by the National Monetary Council (Conselho
Monetário Nacional – CMN)1 and
announced 15 Circulars to be enacted by the Board of
Bacen2 that implement in Brazil the recommendations of
the Basel Committee on Banking Supervision regarding capital
structure of financial institutions of the Brazilian Financial
System (Sistema Financeiro Nacional- SFN). This
article outlines the main information disclosed by Bacen about this
matter.

The new rules are known as Basel III (BIII) and seek to improve
the ability of financial institutions to absorb shocks,
strengthening financial stability and the promotion of sustainable
economic growth. The increase in the quantity and quality of
regulatory capital held by financial institutions is designed to
reduce the likelihood and severity of banking crises, and their
consequent costs for the real economy.

The first three CMN Resolutions deal with the following
matters:

(CMN Res. No. 4192 about new regulatory capital calculation
methodology, named in Brazil "Equity Reference"
(Patrimônio de Referência - PR), which will
continue to be divided into Tiers I and II;

CMN Res. No. 4193 about new capital maintenance requirement
calculation methodology, adopting minimum requirements of PR, Tier
I (Nível I) and Common Equity (Capital
Principal), and introduction of Additional Common Equity
(Adicional de Capital Principal); and

CMN Res. No. 4194 about optional new minimum capital
requirements calculation methodology for credit unions
(cooperativas de crédito) by determining the amount
of risk-weighted assets (RWA) in simplified form, known as
Simplified Prudential Regime (Regime Prudencial
Simplificado - RPS), and introduction of Additional Common
Equity specific to these credit unions.3

Additionally, there is CMN Res. No. 4195, which deals with the
new way of preparation and remittance of aggregate information
through the Analytical Trial Balance Sheet - Prudential
Conglomerate (Balancete Patrimonial Analítico –
Conglomerado Prudencial). Prudential conglomerate is a new
type of consolidated financial statement which will be the basis
for calculation of capital requirements and Additional Common
Equity of financial groups. It will cover financial institutions
and other entities ("related entities") which are not
deemed to be financial institutions but must be authorized to
operate in Brazil by Bacen, as well as some companies controlled by
financial institutions, such as consortium administrators; payment
institutions that act as credit card issuer or merchant acquirer;
companies that carry out the acquisition of credit operations,
including real estate and credit rights, comprising factoring
companies, securitization companies and special purpose companies;
insurers, reinsurers, capitalization companies and open private
pension entities; investment funds in which the entities of the
same conglomerate retain substantially risks and benefits, such as
exclusive investment funds, credit rights investment funds and
other financial investment funds; and legal entities headquartered
in Brazil incorporated with the exclusive purpose of holding equity
investments in financial institutions, related entities or any
other companies already mentioned herein.

The new methodology for calculation of the regulatory capital
brings substantial advances in relation to the current methodology.
The financial institutions´ capital quality is improved by
restriction on the acceptance of financial instruments that do not
demonstrate effective capacity to absorb losses and by deducting
assets that, in certain situations, may compromise the value of the
capital due to its low liquidity, future income dependency to
realization or difficulty of measuring its value.4 In
the case of Brazil, the most significant deductions relate to
deferred tax assets, intangible assets and investments in
non-controlled companies that operate in the insurance
business.

The calculation of minimum capital requirements is established
as a percentage of the amount of RWA. The new rules establish three
independent requirements to be followed continuously by the
financial institutions:

4.5% for the Common Equity, which is composed mainly of shares,
units (quotas), reserves and retained earnings;

6% for Tier I, which is composed of the Common Equity and other
instruments capable of absorbing losses while the institution is
operating (going concern); and

8% for the total of PR, which is composed by Tier I and other
subordinated instruments able to absorb losses when the institution
is closed.

The Additional Common Equity is a supplementary capital created
to reduce the pro-cyclicality of capital requirement and to
establish a gradual range of supervisory actions and corresponds to
the conservation (fixed) and counter-cyclical (variable) buffers
provided for in BIII. At the end of the transitional period, the
Additional Common Equity must correspond to at least 2.5% and up to
5% (maximum) of the amount of RWA, and its exact value will be set
forth by Bacen pursuant to the macroeconomic context. Under normal
market conditions, it is expected that the financial institutions
maintain a surplus of capital in relation to the minimum
requirements to the established Additional Common
Equity.5

The new capital requirement of BIII significantly increases the
percentage of application, mainly from components of PR with
greater capacity to absorb losses.

Implantation in Brazil of the new capital structure starts in
October 1st, 2013 and follows the agreed international schedule
until the completion of the process, in January 1st, 2022. The
schedule for phasing-in of the measures aims to provide sufficient
time for the adaptation of the national financial systems, allowing
each of the institutions, when necessary, to adjust their capital
base. Changes related to the calculation of capital for credit risk
that not imply additional capital and can be implemented easily
already came into effect as of March 1st, 2013.

As from 2014 the financial institutions will have to use the
Analytical Trial Balance -Prudential Conglomerate to calculate the
PR and the new minimum capital requirements to be required of the
regulated institutions. Its creation has ensured that the
accounting document could adequately reflect the economic,
financial and equity positions of the financial groups and the
risks arising out of the operations consolidated there, in order to
facilitate the monitoring and analysis of this information by
Bacen.

The approved Circulars complement the rules laid down in the
Resolutions, establishing the procedures to determine the amount of
RWA and also introduce several operational adjustments and naming
changes which are necessary for the new capital structure, bringing
significant advances in risk measurement and methodology in the
calculation of the amount of RWA for market and operational credit
risks.

According to BIII, exposure to clearing and settlement clearing
houses, which were outside the regulatory scope, will now receive a
2% weight, compatible with the offered security mechanisms.
Over-the-counter (OTC) derivative transactions will also need new
capital requirement to tackle the risks of market value adjustments
due to changes in credit quality of the counterparty.

The Circulars also enhance treatment for exposure to investment
funds, titles of securitization and credit derivatives, among
others. Adjustments are made in certain risk weighting factors
(fator de ponderação de risco - FPR) seeking
to adapt the current methodology to the new structure of BIII,
mainly in relation to exposure related to certain real estate
loans, consigned credits (payroll loans) and loans to large
companies. In line with the existing approaches to credit and
market risk, the Circulars allow financial institutions applying to
use internal models for the calculation of regulatory capital for
operational risk.

The main changes affecting real estate loans are the following:
(i) loans guaranteed by fiduciary alienation, if the financed
amount represents less than 80% of the value of the asset –
the FPR is 35%; (ii) loans guaranteed by mortgage, if the financed
amount represents less than 80% of the value of the asset –
the FPR is 50%; and (iii) loans guaranteed by fiduciary alienation
in the case of residential real estate (home equity) – the
FPR is 50%.

The FPR of the consigned credits with term exceeding 60 months,
which is considered low risk, is now reduced to 150%. The FPR of
all the other modalities of credits granted to individuals, that
represent higher risk, continues to be 300%.

In the case of the exposure of large companies whose aggregate
amount of loans (active portfolio) in the SFN exceeds R$ 100
million, if the value of the active portfolio of such company in a
certain institution is less than 10% of the PR of the institution,
the FPR has been reduced from 100% to 75%. According to Bacen, the
level of default of the large companies is substantially lower than
the exposure represented by the small and medium size
companies.

Regarding the exposure to exchanges, in the case of exposures
arising from own operations to be settled in clearing and
settlement systems by clearing houses or providers of clearing and
settlement services, the FPR is 2%, when the clearing house or
service provider acts as a central counterparty. This measure aims
to encourage these operations with consequent reduction of the
systemic risk. Credit operations maturing in up to three months
carried out directly with such entities has a FPR of 20% and if the
maturity term exceeds three months, the FPR is 50% - this treatment
equalizes the clearing houses and service providers to financial
institutions and related entities. For exposures held by financial
institutions in default funds (funds for liquidation of
transactions in the exchange environment), the FPR is 1,250%.

The large stock of deferred tax assets of the Brazilian banks,
estimated at approximately R$ 60 billion, will continue to be
regarded as capital reserve. As determined by BIII, tax credits
that depend on the generation of future taxable income or profits
to be realized will be deducted from the Common Equity. The
President of the Republic enacted Provisionary Measure (Medida
Provisória) No. 608, of February 28, 2013 (MP
608/2013), which deals with assumed credit calculated on the basis
of credits arising from temporary differences from bad debt reserve
(provisões para créditos de
liquidação duvidosa - PCLD) in accordance with
the conditions established therein and regulates credit securities
and instruments issued by financial institutions and other entities
authorized to operate by Bacen for formation of PR.

According to MP 608/2013, the PCLD arising in Brazil began to be
liquid and certain since their exploitation can occur regardless of
the existence of future profitability. Thus, these specific tax
credits will not be deducted from the Common Equity. As the
deferred tax assets credits arising from tax losses and negative
social contribution basis and tax credits arising from temporary
differences that are not originated from the PCLD, like those
resulting from passive reserves, will compose the basis for
deductions.

In the SFN the most significant deductions are those relating to
tax credits that depend on future income or profits to be realized
and deferred tax assets arising from tax losses. In some
institutions the deductions for intangible assets, actuarial assets
related to defined benefit pension funds and minimum capital
required for insurance companies are also important.

Some of the deductions will not be made in its entirety. Direct
or indirect shareholdings exceeding 10% of the share capital of
other non-consolidated related entities and tax credits arising
from temporary differences that depend on generation of future
taxable income or profits to be realized can form the financial
institution´s capital (PR) in a limited way. Only values
greater than two pre-set limits can be deducted, the individual and
the aggregate, both calculated based on the value determined for
the Common Equity before these deductions. The individual limit is
10% and it is applied both for shareholdings and for the tax
credits. The aggregate limit is 15% and it is applied to the sum of
shareholdings and tax credits after the individual deductions.

The Basel Agreement and CMN's proposal establishes a ceiling
for the participation in the capital of subordinated debt
instruments that do not meet the requirements of BIII. The ceiling
value is reduced 10% annually as from 2013. However this does not
mean that the instruments must necessarily be deducted. For the
most part currently accepted debt instruments would mature in a
relatively short period and would no longer compose the capital
base anyway. The transitional period is long enough so that in most
cases the limits imposed by the ceiling do not constitute an
effective restriction. It should be pointed out that the
subordinated debt that falls on the requirements set out in BIII,
including that submitted the contractual changes to fall on the new
requirements, will be fully recognized as PR.

Pursuant to MP 608/2013, the financial institutions6
and related entities can issue Financial Bills (Letras
Financeiras - LFs) convertible into shares to replace the
subordinated debts. The relevant changes introduced in the
legislation that regulates the issuance of LFs7 are
commented in the subsequent paragraphs below.

The conversion into shares cannot result from the initiative of
the holder or the issuer of the LF. The LF convertible into shares
can be used for purposes of composition of the PR of the issuer,
subject to the conditions specified by CMN. The standards published
by CMN may provide order of preference in the payment of holders of
LFs, according to the characteristics of the credit instrument.

CMN may regulate: (i) the type of institution authorized to
issue; (ii) the use of indices, rates or remuneration
methodologies; (iii) the maturity, which cannot be less than one
year; (iv) the conditions for early redemption of the credit
instrument, which can only occur in competitive trading
environment, subject to the minimum time limit of expiration; (v)
the issuance limits, which are determined according to the type of
institution; (vi) the maturity conditions; (vii) the situations in
which occurs the suspension of payment of the agreed remuneration;
and (viii) the situations in which occurs the extinction of the
right of claim or conversion of the credit instrument into shares
of the issuer.

For the purpose of preserving the proper functioning of the SFN,
Bacen may determine, in accordance with criteria established by
CMN, the extinction of debts evidenced in securities and other
credit instruments allowed to compose the RF of the financial
institutions or related entities, or the conversion of these
securities or credit instruments into shares of the issuer, issued
after March 1, 2013 or agreed upon in order to provide for this
possibility. This extinction of debts or conversion into shares is
final and irreversible and will persist even if performed
improperly, and in any of these two hypotheses any disputes shall
be settled in damages.

The extinction of debts, the conversion into shares or the
suspension of payment of the remuneration stipulated in the
securities or instruments are not deemed to be events of default or
other factors that generate the anticipation of debt maturity in
any legal business involving the issuer or another entity of the
same economic-financial conglomerate as defined by CMN. The clauses
that assign to the events described therein the following
consequences are null and void: (i) anticipation of debt maturity.
(ii) increase of the interest rates or other forms of remuneration;
(iii) requiring the provision of guarantees or its increase; (iv)
payment of any amount; or (v) another consequence to achieve
practical effects similar to those referred to in items (i) to
(iv), even if made through derivative contracts.

If the conversion into shares result in the possibility of
transfer of a controlling interest of the issuer, the exercise of
voting rights inherent to the shares resulting from the conversion
and liable to change the control of the institution must be
authorized by the competent government authorities.

Bacen expects the Additional Common Equity to be complied with
in situations of normality in the economic cycle. The
non-compliance will subject the institutions to restrictions on
payments of bonus, profit participation and other deferred
compensation tied to performance. The degree of restriction will be
escalated in a manner proportional to the degree of inadequacy in
meeting the Additional Common Equity, in order to allow for the
recapitalization of the institution and the return to full
compliance with the requirements and the Additional Common
Equity.

In this sense, MP 608/2013 determines that the distribution of
dividends provided for in articles 202 and 203 of Law No. 6404, of
December 15, 1976 (the Brazilian Corporation Law)8 to
the shareholders of financial institutions and other related
entities shall be subject to the fulfillment of the prudential
requirements established by CMN.

The changes in the current regulations are in accordance with
the recommendations of BIII and are a consequence of the continuous
movement of improvement of the prudential framework applicable to
financial institutions.

Footnotes

1The four CMN Resolutions are numbers 4192,
4193, 4194 and 4195, all dated March 1st, 2013.

3The RPS considers only the exposure to credit
risk for the purposes of capital requirements and a fixed value for
the Additional Common Equity of credit unions, with the aim of
reducing the regulatory cost but ensuring that credit unions have
sufficient capital to withstand losses.

4BIII introduced certain deductions known as
"prudential adjustments" (ajustes
prudenciais), which correspond to the deduction of
assets that may compromise the quality of Common Equity as a result
of their low liquidity, difficult evaluation or future income
dependency to be realized. The major prudential adjustments are:
tax credits arising from temporary differences that depend on
generation of future taxable income or profits to be realized;
investments in related entities; non-controlling interest in
subsidiaries of the same conglomerate and deferred tax assets
arising from tax losses and negative social contribution
basis.

5Bacen studies indicate that in credit growth
scenario and retention results based on the average of recent
years, the SFN as a whole will maintain higher capital than the
values required by the new structure of BIII. These simulations do
not indicate any need for Additional Common Equity for the SFN as a
whole from 2014 to 2019, beyond those values resulting from the
current practice of withholding results. Even lowering the estimate
for the individual institutions level, no bank would need to raise
capital in 2013, 2014, 2015 and 2016. Nevertheless, as from 2017,
due to the diversity of portfolios, there are banks that need to
raise some small amounts of capital. Together, those few banks
would need about R$ 2.9 billion in 2017, R$ 5.1 billion in 2018 and
R$ 6.7 billion in 2019. This represents added up to 2019 about R$
15 billion, which corresponds to approximately 2% of the PR of the
SFN in December 31, 2012 (R$ 697 billion).

7The LF was created by Provisional Measure No.
472, of December 15, 2009, which was approved by the Brazilian
Congress and converted into Law No. 12249, of June 11, 2010 (Law
12249/2010), and is now amended by MP 608/2013. It is a credit
document that constitutes a promise of payment in cash, issued in
the registered form, which may be transferred to third parties and
it is freely negotiable. It must be exclusively issued in
book-entry form, through the registration in a registry and
financial settlement of assets system authorized by
Bacen.

8Articles 202 and 203 of the Brazilian
Corporation Law establishes that:

"Article 202. In every fiscal year, the
shareholders shall be entitled to receive as a compulsory dividend
the portion of the profits as may be stated in the bylaws or, in
the event the latter is silent in this regard, the amount to be
determined as follows:

I – half of the net profit as increased or
reduced by:

a) the amount intended to form the legal reserve
(Article 193); and

b) the amount intended to form the reserves for
contingencies (Article 195) and any written-off amounts of the same
reserves formed in previous fiscal years;

II – the payment of dividends provided for in
item I may be limited to the amount of net profits realized during
the fiscal year, provided that the difference is recorded as a
reserve for realizable profits (Article 197);

III – profits registered in the reserve of
realizable profits, when realized and not absorbed by losses in
subsequent fiscal years, shall be added to the first dividend
declared after their realization.

Paragraph 1. The bylaws may prescribe the dividend as a
percentage of the profits or of the capital, or establish other
criteria for its determination, provided they are prescribed
adequately and in detail and do not subject the minority
shareholders to the discretion of the administrative bodies or of
the majority.

Paragraph 2. Whenever the bylaws are silent and the
general meeting resolves to amend the bylaws in order to regulate
compulsory dividends, the compulsory dividend may not be less than
twenty-five per cent (25%) of the net profit as adjusted in
accordance with item I of this Article.

Paragraph 3. As long as no present shareholder opposes
to it, a general meeting may resolve to distribute a dividend which
is less than the compulsory dividend prescribed by this Section or
to retain the entire net profit, in the following
corporations:

I – publicly-held corporations which have gone
public exclusively to raise capital by issuing non-convertible
debentures;

II – closely-held corporations, except those
controlled by publicly-held corporations not in compliance with the
provisions of item I.

Paragraph 4. - The dividend prescribed by this article
shall not be compulsory in a fiscal year in which the
administrative bodies notify the general meeting that its payment
would be incompatible with the financial standing of the
corporation. The audit committee, if in operation, shall deliver an
opinion on any such notice and, in a public corporation, the
officers shall forward to the Brazilian Securities and Exchange of
Commission, within five days of holding the general meeting, an
explanation justifying the notice.

Paragraph 5. - The profits which are not distributed by
virtue of paragraph 4 shall be attributed to a special reserve and,
if not absorbed by losses in subsequent fiscal years, shall be paid
as dividends as soon as the financial situation of the corporation
permits such payment.

Paragraph 6. The profits which are not allocated
pursuant to Sections 193 to 197 shall be distributed as
dividends.

Article 203. The provisions of articles 194 to 197 and
of article 202 shall not impinge on the right of the preferred
shareholders to receive the fixed or minimum dividend for which
they have priority, including overdue dividends, if
cumulative."

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
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or if a user no longer desires our service, we will endeavour to provide a way
to correct, update or remove that user’s personal data provided to us. This can
usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will
post those changes on our site so our users are always aware of what information
we collect, how we use it, and under what circumstances, if any, we disclose it.
If at any point we decide to use personally identifiable information in a manner
different from that stated at the time it was collected, we will notify users by
way of an email. Users will have a choice as to whether or not we use their
information in this different manner. We will use information in accordance with
the privacy policy under which the information was collected.

How to contact Mondaq

If for some reason you believe Mondaq Ltd. has not adhered to these
principles, please notify us by e-mail at problems@mondaq.com and we will use
commercially reasonable efforts to determine and correct the problem promptly.